VASANT RAJ PANDIT,MUMBAI vs. ACIT 20(3), MUMBAI

1.3 The assessee, vide letter dated 06/06/2014 has raised an additional ground which is without prejudice ground and read as under: - The donations made by the appellant to charitable institutions be allowed to the appellant as a deduction u/s.80G of the Income Tax Act, 1961.

We have carefully heard the rival submissions and perused relevant material on record including documents placed in the paper- book. Our adjudication in the subject matter of appeal would be as given in succeeding paragraphs. Assessment Proceedings 4. The material facts are that the assessee being resident individual stated to be engaged in the business of marketing of medical products and herbal cosmetics under proprietary concern namely M/s. Frontier Trading Co. was assessed for the year under consideration u/s 143(3) on 27/03/2006. The subject matter of this appeal is disallowance of incentive payment and denial of set-off of business losses & depreciation claim. The same has been dealt with by us in succeeding paragraphs. Disallowance of incentive payment 5.1 The assessee’s proprietorship concern i.e., M/s Frontier Trading Co. operated as ‘Multi- Level Marketing Concern’. During the year, it traded in imported Magnetic Acupressure Treatment Instruments. The modus operandi of the business was that the assessee would appoint Independent Representatives (in short ‘IR’) who would market and sell the products of the assessee against inventive / commission. The IRs would also recommend others who would, in turn, be appointed as IRs and so on. When the subsequent appointed IRs would sell products, the IR with whose reference the subsequent IR was appointed, would also be paid commission of a specified amount. The IRs had sales target and if the said targets are not achieved, then as per clause (3) of the terms and condition of appointment agreement of the IR, the assessee had a right to withheld or forfeit the amount of incentive / commission payable to such IRs. Although the terms and condition of the appointment provided for withholding or forfeiture of the commission amount, it was the understanding between the assessee and the IRs that in case the sale targets were not achieved then the commission which would have accrued to these IRs would be donated by the assessee on their behalf to various charitable institutions as per the scheme formulated by the assessee. 5.2 During this year, the assessee paid incentive / commission of Rs.5048.19 Lacs which was approx. 1/3rd of total sales achieved by the assessee. The number of IRs to whom incentive / commission payment exceeding Rs.1 Lacs was made, numbered to more than 910. During the course of assessment proceedings, the assessee was required to file the requisite details and documents, in this regard. 5.3 To confirm these payments, Ld. AO issued notice u/s 133(6) to 54 of such IRs on a sample basis. However, only 6 IRs responded and furnished the details as called-for by Ld. AO. The outcome of replies received from these IRs has been tabulated on page-3 of the assessment order. The amount of payment as per list furnished by the assessee vis-à-vis confirmation filed by these IRs with respect to ‘payment / receipts accepted’ was at variance and accordingly, the assessee was put to show-cause notice. The assessee, in reply, submitted that difference arose due to difference in method of accounting being followed by the two i.e., the ‘accrual basis’ by the assessee and ‘cash basis’ by the recipient IRs. The assessee also demanded detailed statements so as to reconcile the figures. 5.4 Another allegation of Ld. AO was that the assessee had violated the provisions by not deducting tax at source while making these payments. The incentive amount forfeited and paid as donations by the assessee was claimed as business expenditure u/s 37(1) as well as deduction thereof was claimed by the assessee on these donations u/s 80G. The assessee did not issue any TDS certificates to the IRs and the whole transactions was bogus and bereft of any legal support. Therefore, the payment thus made could not be allowed as deduction. 5.5 To support the conclusions, Ld. AO referred to correspondence between CIT(A), Thane and CIT(A)-20 Mumbai, in the case of one IR namely Shri Umesh N. Chavan of Thane who was in appeal before CIT(A), Thane challenging the assessment order holding that donation of Rs.4,99,500/- for AY 1999-2000 and Rs.8,33,362/- for AY 2000-2001 was not his income since the same was not donated on his behalf. Before the CIT(A) Thane, it was the case of the IR that the forced donations were without his consent, which stand was taken by Shri Umesh N. Chavan for the first time before the CIT(A), Thane, after a long delay of four years. 5.6 On the basis of above facts, Ld. AO concluded that incentives which were donated on behalf of the IRs had not accrued to the IRs and that the Appellant was debiting bogus incentives in its books. Hence, the books of accounts of the assessee were rejected. Finally, based on the proportion of incentives shown by six IRs in the confirmation received u/s 133(6) of the Act, Ld. AO disallowed 50% of incentives claimed by the assessee in the Profit & Loss Account. Business Loss & Depreciation Claim 6.1 It transpired that the assessee had promoted another concern i.e., M/s JLI insurance Brokerage Co. (JLI) during the year. This concern reflected income of Rs.19.67 Lacs and claimed expenditure of Rs.120.42 Lacs thereby reflecting losses of Rs.100.74 Lacs. After adjusting the admissible depreciation, the losses worked out to be Rs.141.69 Lacs which was set-off against the profits of M/s Frontier Trading Co. The Ld. AO opined that this entity was formed as a device to reduce the gross profits of the parent concern and accordingly the assessee was put to show cause notice on 26/12/2005. 6.2 The assessee controverted the allegations of Ld. AO by submitting that this entity was engaged in the business of providing insurance brokerage services. This concern had tied up with number of reputed insurance companies such as LIC, ICICI Prudential, TATA AIG, HDFC Standard, Birla Sunlife, New India Insurance, Oriental Insurance, General Insurance etc. to provide insurance brokerage services. This entity was stated to be duly registered with regulatory authority IRDA and holding license w.e.f. 30/01/2003 for carrying out brokerage business. It was explained by the assessee that insurance brokerage business was a specialized business driven by insurance processionals which call for intensive training and regulatory compliances. Accordingly, this concern recruited 39 insurance professionals apart from supporting accounts and administrative personnel. The concern had offices at 21 locations doing the business of brokerage. Since the business was of specialized nature, the preparatory and orientation effort had to begin well before the issuance of license by IRDA. It was normal for such business to have gestation period of 2-3 years before cash profit would accrue. The same was sought to be supported by the fact that during the year, this concern generated 1208 proposal for various insurance companies involving sum assured of more than Rs.8.70 Crores with premium aggregating to more than Rs.84 Lacs. This would clearly denote that there was bona-fide business carried on by M/s JLI. As per the requirement of IRDA, the insurance brokerage business had to be necessarily carried out by a separate entity and it was therefore, imperative to set up this concern for brokerage business. Further, this entity had had an arrangement with M/s Frontier Trading Co. for obtaining market intelligence data and for availing processing assistance. By the said arrangement, M/s Frontier Trading Co. harnessed large number of distributors to compile a prospect database, fill up questionnaires and submit them to insurance professionals in the concern. The market intelligence arrangement with M/s Frontier Trading Co. was a vital component in the functioning of this concern. Along with the reply, the assessee furnished the details of salary paid during the year and finally submitted that M/s JLI was a full- fledged independent insurance brokerage entity legally constituted to carry out the legitimate business of insurance brokerage. 6.3 However, it was observed by Ld. AO that this entity was started in this year and it booked huge losses in the very first year of operations. In fact, in the very next AY 2004-05, this entity was converted into a private limited company against issue of 99% of its share capital to the assessee. This private limited entity paid an amount of Rs.213.23 Lacs to M/s Frontier Trading Co. as marketing intelligence collection charges during AY 2004-05. Therefore, the receipt of M/s JLI, in the first year, were very small against which the assessee claimed huge depreciation as well as business losses. In the next year, when the private limited entity earned substantial income, it paid the market intelligence charges to M/s Frontier Trading Co. Resultantly, there would be lesser tax liability to proprietary concerns as well as on private limited entity. Thus, the creation of M/s JLI was a colorable device. Therefore, the set-off of losses was denied to the assessee. Consequently, the depreciation of Rs.54.47 Lacs claimed on computer, furniture & fixture and Business Development rights was also disallowed. The Business development rights were nothing but pre-operative expenses incurred on training the staff and cost of identifying various locations of business. The same were considered by the assessee to be enduring in nature and depreciation was claimed on the same @25%. Appellate Proceedings 7.1 During appellate proceedings, the assessee submitted that to ensure compliance by third parties was not in the control of the assessee and therefore, the assessee could not be held responsible for non- compliance of notices issued u/s 133(6). The replies furnished by six IRs could not be the sole basis of making such a huge addition. The amount claimed by the assessee was as per accrual method of accounting whereas IRs reported the income which was actually received by them. The assessee also submitted that IRs were fully aware of the scheme of donation made on their behalf which is evident from the fact that IRs claimed deduction u/s 80G in their return of income. The IRs were fully aware of the fact that in case sales targets were not achieved, the commission would be forfeited and paid to charitable institutions. It was also submitted that donations constituted only 2.69% of overall incentive debited in Profit & Loss Account. The assessee also denied having availed deduction u/s 80G on these donations. 7.2 Keeping in view the submissions made by the assessee, the matter was remanded back wherein summons were issued by Ld. AO to all the 972 IRs. However, only 177 IRs responded back, the result of which could be tabulated as follows: - No. of IRs Amt. of Amt. of Amt. of Amt. Donation who replied Incentive incentive incentive received paid shown by the receivable actually after assessee by the party received by 31.03.2003 (IRs) the party 177 4,10,73,080.51 1,67,320,218 2,84,40,025 11,77,523 11,53,911 The Ld. AO, in remand reports dated 12/09/2006 & 13/04/2007 reiterated that the additions made in the assessment order was to be confirmed. The assessee, on the other hand, controverted the findings of Ld. AO by drawing attention to the fact that the replies could not be considered as whole truth since in case of some IRs the amount received by them was much more than the amount claimed by the assessee and the variance was only a matter of reconciliation. The assessee also drew attention to the fact that there were contradictions in the replies furnished by IRs. 7.3 The Ld. CIT(A), after considering the remand report as well as assessee’s submissions, noted that the incentive as percentage of sales in AY 2000-01 was 47.77% which reduced to 33.39% in this AY which could be due to reduced sale and crash of assessee’s business. It was further noted that there were discrepancies in the statements of most of the 177 IRs who responded to the summons but the same could not be reconciled by the assessee. A large number of IRs (487 in number) did not respond to the summons and in case of 308 parties, the summons was returned back undelivered. In case of one of the IR namely Shri Unmesh N. Chavan, the assessee claimed to have paid an amount of Rs.60.05 Lacs. However, only Rs.55.06 Lacs were actually paid and balance Rs.4.99 Lacs were paid in Charity without his consent since the IR could not achieve the sales target to that extent. The agreement as entered into by the assessee with IR, do not contain any stipulation regarding any incentive or part thereof due to IR to be given as donation to charity. All that the agreement said was that IRs would not have any claim on the incentive to which they may be entitled in case it is withheld or forfeited on account of failure on the part of the IRs. Therefore, the disallowance of 50% as estimated by Ld.AO was justified. 7.4 Regarding set-off of losses of M/s JLI, the assessee submitted that Ld. AO on one hand disallowed the expenditure of M/s JLI but on the other hand never reduced the income in the books of M/s Frontier Trading Co. on account of marketing intelligence fees paid by M/s JLI to M/s Frontier Trading Co. Thus, there was contradiction on the part of Ld. AO. However, going by the remand report, Ld. CIT(A) noted that the assessee did not file details in respect of amounts debited in Profit & Loss Account along with supporting documents & vouchers. Therefore, the set-off of losses could not be allowed to the assessee except to the extent of Rs.51.82 Lacs being marketing fees paid by M/s JLI to M/s Frontier Trading Co. which was reflected as income in the books of M/s Frontier Trading Co. The balance disallowance of Rs.48.91 Lacs was confirmed. The action of Ld. AO in disallowing the depreciation was also confirmed. 7.5 Aggrieved as aforesaid, the assessee is in further appeal before us. Our findings & Adjudication- Disallowance of incentive payment 8.1 Upon perusal of assessee’s business model, we find that the assessee was engaged in trading of imported Magnetic Acupressure Treatment Instruments. The business was in the nature of Multi-Level Marketing Network wherein the customers who purchased the product become eligible to be enrolled as Individual Representative (IR). An IR who has personally experienced the benefits accruing to him as an IR would share the same with his friends, relatives and business associates. The interested potential buyers would then be invited to attend a seminar at the showroom where they would be introduced to the product and also to the business opportunities that they could avail by buying the product and registering as an independent representative. Thus, initially the assessee would appoint independent IRs who would sell the product as well as introduce new IRs in the chain. When new IRs would sell the product or bring new IRs, the chain would be enlarged and accordingly, the commission would be distributed to the assessee as well as earlier chain of IRs who introduced such an IR. The sales targets would be given to IRs by the assessee. In case the sales targets were not achieved, then the commission that would have accrued to the IRs would stand forfeited. Thus, it could be seen that there would be large chain of IRs working under the assessee to whom the commission would be paid by the assessee. Keeping in view the nature of business, it was quite possible that the assessee would not know large number of IRs present in the chain. In such a case, the assessee’s explanation that furnishing of replies by IRs would not be in the control of the assessee, was to be accepted and the same was a plausible reasoning. 8.2 Proceeding further, as per the terms of the agreement, if sales targets were not achieved by the IRs, the assessee was entitled to withhold / forfeit the amount of incentive with an understanding that such forfeited amount would be donated by the assessee to charitable organization on behalf of the IRs. This arrangement is evident from the fact that the several IRs, in reply to the summons, have accepted this fact. The same is also evident from the finding of Ld. AO that during remand proceedings, IRs have accepted that donation of Rs.11.53 Lacs was paid by the assessee on their behalf. The case of Shri Umesh Chavan, which form the basis of opinion of Ld. AO, is a case where this fact has been disputed only when his appeal was pending before learned first appellate authority and that too after a period of 4 years. In his case, the assesseing officer had treated the donation as his income which would support the case of the assessee that there was such an arrangement between the assessee and the IRs. 8.3 It is apparent that there is no change in assessee’s mode of operation of the business. The incentive / commission paid by the assessee, in similar manner, has been allowed by Ld. AO in scrutiny assessment proceedings u/s 143(3) for AYs 1998-99, 2000-01 & 2001- 02. It is also evident from the impugned order that the ratio of incentive paid by the assessee vis-à-vis sales has, in fact, fallen over various years which is evident from following tabulation: - AY Incentive as percentage of Sales 2003-04 33.39 % 2002-03 42.64 % 2001-02 46.14 % 2000-01 47.77 % It could be seen from the above table that the assessee has paid commission of 47.77% & 46.14% in AYs 2000-01 & 2001-02 respectively and the same has been accepted by Ld. AO in the scrutiny assessment. This ratio has ultimately been fallen to 33.39% in this year and therefore, the same could not be held to be excessive or unreasonable considering the facts in earlier years. 8.4 Proceedings further, it could be observed that the assessee had furnished complete details viz. Name, Address and PAN of all IRs including amounts payable to each of them. The same has enabled Ld. AO to issue summons to all the IRs during remand proceedings. Pertinently, the assessee has deducted applicable TDS u/s 194H which is evident from assessee’s submissions as noted by Ld. CIT(A) in para- 2.10 (i) of the impugned order. It was submitted by the assessee that there was no lapse regarding TDS since the assessee had deducted TDS u/s 194H and furnished copies of TDS certificates. In this background, non-furnishing of reply by IRs could not be attributed to any lapse on the part of the assessee and there is no substance in the allegation of Ld. AO that the commission was paid in violation of TDS provisions. 8.5 So far as the difference in incentive commission reported by IRs vis-à-vis incentive commission claimed by the assessee is concerned, it could be gathered that Ld. AO has inquired only about the commissions actually received by the IRs during the year and not the figures of gross commission accrued to them during the year. There would always be difference in the two figures in view of the fact that the assessee was accounting incentive commission on accrual basis whereas IRs were asked to supply the figures of commissions actually received by them during the year. Another factor of variance would be that the assessee has deducted TDS on these payments and therefore, the amount actually received by IRs would be less. More so, as per the terms of the agreement, the incentive / commission amount could be forfeited by the assessee under certain circumstances which would have been paid as donation to charity. In such a case, the assessee would account such an expenditure on gross basis including the amount of donation but the same would never be reported to have been received by IRs. Therefore, the nature of inquiry as made by Ld. AO, would not support the case of the revenue. 8.6 It could be observed that replies were received by Ld.AO during remand proceedings from 177 IRs, the result of which (as detailed in the impugned order) was as follows: - No. of IRs Amt. of Amt. of Amt. of Amt. Donation who replied Incentive incentive incentive received paid shown by the receivable actually after assessee by the party received by 31.03.2003 (IRs) the party 177 4,10,73,080.51 1,67,320,218 2,84,40,025 11,77,523 11,53,911 It could be seen that aggregate amount reported to be receivable by the IRs was Rs.167.32 Lacs and the amount actually received by them was Rs.284.40 Lacs. The total of the two figures would be Rs.451.72 Lacs (Rs.167.32 Lacs + Rs.284.40 Lacs) which is much more than the amount of Rs.410.73 Lacs as reflected / claimed by the assessee in its books of accounts. Therefore, the variation was only a matter of reconciliation only and there was no case of any excessive claim being made by the assessee which could be disallowed by Ld. AO. On the facts of the case, the burden was on revenue to show that the claim was incorrect. Further, the replies received from 177 IRs out of 972 IRs, could not be extrapolated to disallow expenditure to huge extent of 50% as claimed by the assessee. The rule of consistency would debar revenue to make such a disallowance. 8.7 The Ld. AR, in the additional ground of appeal, has pleaded for grant of deduction u/s 80G in case a view was taken that donation was not paid by the assessee on behalf of the IRs and therefore, the deduction of expenditure could not be allowed to the assessee. We find that it is the consistent stand of the assessee that there was an understanding that forfeited amount was to be paid as donations to charity. In fact, many IRs have also confirmed this fact. It is also pertinent to note that deduction u/s 80G has been claimed by many IRs in their respective return of income since the donations have been made on their behalf against receipts which have also been issued in their respective names. In such a case, no substance could be found in the alternative claim of the assessee. The same is bereft of any merit and hence, dismissed. 8.8 We find that this appeal pertains to AY 2003-04 and the case was already subjected to remand proceedings by learned first appellate authority. In fact, Ld. AO has submitted three remand reports in the case. Keeping in view the same, we would like to put an end to litigation by rendering concrete findings in the case. Therefore, on the facts and circumstances of the case as well as keeping in view our findings and observations as enumerated in preceding paragraphs, to plug the leakage of revenue, we direct Ld. AO to disallow 0.5% of incentive commission claimed by the assessee during the year. The same works out to be Rs.25,24,100/-. The balance addition stand deleted. The grounds thus raised stands partly allowed.